Low Interest Rates: Bad for Retirees, Worse for Gen X-ers

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Dan Caplinger is an attorney and financial planner covering retirement, ETFs, personal finance, and general investing for the Motley Fool. With nearly 20 years of diverse experience as a tax and estate planning lawyer, trust administrator, personal financial advisor, and independent consultant, Dan has developed a healthy skepticism of the mainstream financial industry and aims to make complex legal and financial concepts easier for his readers to understand. Dan has worked with the Motley Fool since 2006 as a retirement, tax, and investing expert with a focus on introducing new investors to the opportunities of smart financial planning.

For years, low interest rates have hurt retirees trying to generate enough income from their retirement savings to cover their living expenses. But the biggest impact from low rates on retirement prospects could well hit current workers, including those who are still more than a decade away from retiring, according to a recent study from the Employee Benefit Research Institute.

The Impact of Low Rates on Retirement Readiness

Obviously, for retirees who are living in part on investment income, low rates have an immediate impact on their standard of living. With few prospects to add to whatever they've managed to set aside in their retirement nest eggs, retirees are largely at the mercy of banks and other financial providers that determine how much interest they're willing to pay their customers on their investment balances. With rates on certificates of deposit having fallen from around 4.5 percent five years ago to less than 1.5 percent today, according to figures from Bankrate, the roughly 3-percentage-point drop equates to about $250 less in monthly interest income for every $100,000 in savings a retiree has.

But for those who are counting on long-term returns from their investments to help them get ready for retirement, the EBRI study reveals an equally troubling trend. The study found that among baby boomers and members of Generation X, fully 25 to 27 percent of those who would have had adequate income to retire comfortably based on historically normal interest rates won't earn enough investment income if low rates continue indefinitely.

In particular, the study looked at two assumptions, one under which bond rates had returns equal to the rate of inflation, and the second under which bond rates stayed at their current level below the inflation rate. In the first case, retirement-readiness rates dropped by about 10 percentage points, cutting the figures from 55 percent to 45 percent for the older portion of the baby boom generation, and from 57 percent to 47 percent for younger boomers and members of Generation X. The lower-rate scenario pulled success rates down even further, to roughly 40 percent for early boomers, 42 percent for late boomers, and 43 percent for Gen X.

The results varied a lot more when the study looked at income levels. For low-income workers, interest rates don't matter very much, because even under current conditions, only 1 in 6 workers has enough saved to produce income to cover their expenses. As income levels rise, though, the impact gets larger, with the top half of income-earners seeing declines of 17 percentage points in their retirement readiness.

Will Rates Stay Low Forever?

One key question for retirees and workers is whether today's low-rate environment will last permanently. When the study looked at scenarios in which temporary low-rate conditions gave way to higher rates in the future, the impact was far less severe. In addition, the study saw less extreme impacts when it incorporated other potential sources of income, including Social Security, pension payments, and money from home equity.

Nevertheless, the study supports previous research showing the large impact on retirement prospects from low rates. Another study earlier this year examining the popular 4 percent withdrawal rule for retirement portfolios concluded that low rates had an immense impact on the overall long-term viability of people's retirement savings. Under ordinary scenarios, taking 4 percent withdrawals would successfully preserve a retirement portfolio in all but 6 percent of simulated cases. Under low-rate scenarios, failure rates soared to 33 percent when bond rates equaled inflation and 57 percent when rates stayed at their current levels below the inflation rate.

As challenging as it is to set money aside for retirement, studies like these show how crucial doing so is for your financial future. Without adequate resources, you could find yourself at the mercy of interest rate policies over which you have no control whatsoever -- or having to keep working longer than you'd like in order to make ends meet.

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The amount of cash you can get depends on your age, the type of reverse mortgage you select, the appraised value of your home, current interest rates, and where you live. In general, the most cash goes to the oldest borrowers living in the homes of greatest value at a time when interest rates are low.

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I am a retiree, who lives entirely off my investment income. Low interest rates don't bother me at all. My income is generated by my investments. I do not own a certificate of deposit. I do not have a bank savings acount. My portfolio is heavily invested in equities. So, don't generalize like that. I'm doing quite well.